Sunday, September 19, 2010

I've been following the 'permanent portfolio' theory on and off with one eye for a few years, and it's actually been quite an interesting performer. Especially the past few years with the 2nd massive bear market in a decade in equities, combined with a multi decade bull in bonds (only accelerating of late), and the decade long surge in gold. It is championed by Harry Browne - a quick overview.

The general idea of this approach is that there are four basic classes of investments investors should primarily concern themselves with: stocks, Treasury bonds, cash (Treasury bills), and precious metals. He did some analysis of past trends in those markets and discovered that a portfolio consisting of equal parts of each of those four types of investments was not terribly volatile and had a relatively consistent rate of return.

Of course, such a portfolio would never do as well as one that was over-weighted toward whatever investment was going to go up in the next time period, but unfortunately that information is not available when you need to know it. This approach, on the other hand, does not require precognition, but just some simple mechanical adjustments whenever one of the portfolio segments gets out of balance with the others.

The basic idea is that each of those investments does well under certain economic circumstances: stocks during "prosperity", Treasury bonds during "depression", Treasury bills during "tight money", and precious metals during "inflation". So whatever economic circumstances occur, your portfolio should not be too seriously affected, because whatever investments are depressed by the current circumstances, some of the other ones would counteract that.

The Wall Street journal has a story on this tortoise that beat the hares. A quite amazing story - in August of this year the fund received more inflows than it did in its first 25 years combined!

Imagine going from investing zero to superhero overnight. That is roughly what has happened to Michael Cuggino, manager of Permanent Portfolio. After struggling to stay above $50 million in assets for most of its life, the fund shot past $1 billion in 2007, more than doubled to $3.4 billion in 2008 and swelled to $5 billion last year. So far in 2010, $1.9 billion of new money has come piling in.

In August, according to Morningstar, investors added $327 million to the fund—as much in a single month as Permanent Portfolio had managed to accumulate in the entire first 25 years of its existence. Suddenly, the fund's assets surpass $7.6 billion.

Why? Two words: strong results. In 2008, when the Standard & Poor's 500-stock index lost 37%, Permanent Portfolio lost just 8.4%. In 2009, it lagged behind the stock market but still gained 19.1%; so far this year, the fund is up 6%, versus 2.3% for the S&P 500.

The fund has walloped the stock market by an average of nine percentage points annually over the past five years and 11.2 points annually over the past decade. And it keeps less than a third of its assets in stocks.

Launched in 1982 and based in San Francisco, this eccentric, no-load fund grew out of the ideas of Harry Browne, the author, investment adviser and Libertarian candidate for president. Mr. Browne, who died in 2006, advocated keeping one-quarter of your portfolio in each of four assets: stocks, bonds, gold and cash. Once a year, if any of the assets fell below 15% or rose above 35%, you would buy or sell as needed to rebalance back to 25%. Otherwise, you would do nothing. Mr. Browne called this the "permanent portfolio": a basket of assets you could hold undisturbed for a lifetime. He believed it was "bulletproof" and "fail-safe," protected against drastic loss no matter what the future held.

The Permanent Portfolio fund is not quite as simple as Mr. Browne's four-square approach. Instead, it seeks to keep 20% in gold, 5% in silver, 10% in Swiss francs and bonds, 15% in real-estate and natural-resource stocks, 15% in growth stocks and 35% in cash and U.S. bonds.

Gold and long-term bonds have been the stars of the last decade, driving the Permanent Portfolio's outperformance over stocks, notes Mr. Bernstein. "For the past few years, it's been a nonstop beer-and-pizza party," he says. "But there will come a time when it's just going to be years at Weight Watchers for those assets, and I doubt most investors will have the discipline to stick with this strategy."

Ironically, as Mr. Bernstein points out, Mr. Browne came up with the idea as a way to diversify into stocks and bonds after gold and other "hard assets" became overvalued in the late 1970s. Now, many investors appear to be stampeding into the Permanent Portfolio fund to get out of stocks and into gold and other hot assets.

Although it is designed for capital protection, many of its new buyers seem to be seeking capital appreciation—chasing this fund the same way they chased Internet funds in 1999 and 2000. They could leave just as quickly. As its former auditor, Mr. Cuggino has been involved with Permanent Portfolio since 1985, so he remembers well what such lean years are like. "What we do was very much out of favor for a very long time," he says dryly.

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